David Webb's Time-Bomb Warning On Citic Pacific Should Not Be Dismissed

The following editorial from David Webb should be read in full!

• It turns out that little old ladies buying minibonds aren't the only ones to have been taken in by structured financial products. Hang Seng Index member (for now) CITIC Pacific Ltd (CP, 0267.HK) stunned the market this evening with the extremely late announcement that they are sitting on realised and unrealised losses of HK$15.5bn (US$1.99bn), due to foreign exchange exposures the Company was aware of six weeks ago (although the losses have grown) but had failed to tell investors until now.
  
  The losses involve exotic foreign exchange forward contracts such as "dual currency target redemption forward contracts", where they get a limited upside (due to a knock-out clause) and an unlimited downside, being required to take the weaker of the Australian dollar and Euro. Another series of "AUD target redemption forward contracts" involves receiving up to AUD9.05bn in monthly instalments up to October 2010. The counterparty bank(s) for these contracts have not been disclosed, and CP did not say when the contracts were entered into. They should tell investors how long this time-bomb was ticking. If the exposure pre-dates the interim report for 30-Jun-08 or even the audited annual report for 31-Dec-07 then it raises additional questions. On this, the two reports said (p120 of the annual report):

Read rest of article: http://webb-site.com/articles/citicbomb.htm

And of course the key issue was:

• Why did CITIC Pacific's board wait 6 weeks before telling investors that it had a huge exposure to exotic foreign exchange forward contracts? What does this say about the quality of its board, and the independent directors on its audit committee who, according to a separate statement by the Chairman, found time to complete an investigation of the incident even before the incident was announced?

Even Clare Barnes from Apollo Investment has something to say too!

• Mainstream press reports of CITIC Pacific's US$2bn losses on FX contracts are inadequate. The contract details are interesting (and the losses relative to upside should be salutary), but this is of wider importance for Hong Kong corporate governance: read David Webb on CITIC Pacific's time bomb. This news update mentions counterparties including HSBC, BNP, and Citigroup, and the interesting term "accumulator", which some would associate with the racetrack...
  

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And how about China Again?

Here is a fantastic article written by David Webb on the Chinese stock market.

• What else can you call a US$3.2tn market which has gained 358% in 20 months and trades on a historic P/E of over 60, which is probably closer to 80-100 excluding stock-market and real-estate revaluations from "E". We look at the bubble, the impact on HK, the thru-train, the calls in HK for an A-H arbitrage mechanism, and how the bursting may affect the socio-political system. The absence of a free media is itself contributing to the bubble.

Do give it a read: http://webb-site.com/articles/incredibubble.htm

• By definition, bubbles are markets whose valuations are unsupported by fundamentals. There is nothing to fall back on. Bubbles never just plateau and go sideways - because that would not satisfy investors who bought in expectation of continued rapid gains. As soon as the momentum runs out, those investors head for the exit, and with nobody willing to take their place, the market crashes, usually overshooting fundamental value on the downside. Just a return to the index level of 20 months ago, when valuations of some stocks were beginning to look reasonable, would be a drop of 78%.
  
  Like avalanches and other non-linear phenomena, nobody can exactly predict when a bubble will burst. All they can do is look at the accumulating snow on the mountain, and decide that it is not a good time to go skiing. By staying indoors, they might miss out on some great skiing, but they can be certain of avoiding burial in an avalanche.
  

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